Dear President Trump: Your Tax Plan Needs Bigger Deficits!

U.S. President Donald Trump speaks during the Heritage Foundation's annual President's Club meeting in Washington, D.C., U.S., on Tuesday, Oct. 17, 2017. Trump seeks to rally support for his effort to overhaul the nation's tax code on Tuesday at the conservative policy group that helped write the plan. Photographer: Martin H. Simon/Pool via Bloomberg

The Trump tax plan has generated too many stories to count. So far as I can tell, most have been negative, citing the disproportionate benefits bestowed on corporations and the wealthy versus the poor and middle class (many of the latter may actually take a hit). I differ with these only in detail or degree. The tax package is a terrible idea.

However, there’s another line of criticism with which I fundamentally disagree. I have seen article after article sounding the alarm regarding the impact the tax plan will have on the debt and deficit. Their worry is that the cuts will lead to increasing deficits, an accelerating level of debt, and eventually [insert vague reference to an undefined mega disaster at an unspecified date in the future]. Indeed, this is part of the justification for some of the tax increases included in the bill: they are supposed to offset the cuts. What they actually offset is any usefulness that the plan may have had in the first place, but I’ve already argued that elsewhere (see The Disastrous Trump Tax Plan and Trump's Tax Plan: The Good, The Bad And The Ugly).

What I want to highlight here is this: the private sector needs government deficit spending if it is going to recover properly from both the heart attack of the Financial Crisis and the decades of disease brought on by income redistribution and rising debt levels. This is so because government deficits are private-sector surpluses.

The logic is really very simple. What number do you get when you add up every trade surplus and trade deficit on the planet? Zero, of course, because one nation’s trade surplus is another’s trade deficit. This is a specific application of the general rule that in any closed system, the sum of all deficits and surpluses must be zero. If you and I are the only two people in the economy and I spend more than I earn, then you earn than you spend (and by the exact same amount, of course). There aren’t many inescapable truths in life, but this is one.

Now think about the U.S. government budget deficit. If Washington is spending more than it earns, then non-Washington must be earning more than it spends. In 2016, for example, the US federal government spent $585 billion more than it collected in taxes. That money did not disappear in a puff of smoke. It became the excess of income over spending earned by non-Washington. Non-Washington had a $585 billion surplus or, which is the same thing, $585 billion of savings.

This is an inescapable accounting truth and it implies that any tax plan that hopes to stimulate the private sector must create a budget deficit. Federal government budget surpluses drain non-Washington income. That's hardly what we need. Pundits and policy makers need to stop worrying about Washington’s deficit and start focusing on non-Washington’s surplus.

“Wait,” you may ask, “true or not, doesn’t this just lay the foundation for bigger problems in the future?” Almost certainly not. Let me address a few of the most common worries:

1. The U.S. government will go bankrupt/default on its debt

So long as its debt is denominated in dollars–and it is–it is impossible for the U.S. to be forced into debt default. It’s our money and we can create it with a keystroke. Indeed, through the process is roundabout, that’s precisely what we do all the time. We can never, ever be forced to default on the debt and those who say otherwise either don’t understand the underlying economics or they have an ulterior motive. I know you might find this hard to believe but it is absolutely true. For more see: It Is Impossible For The U.S. To Default.

2. Even if we don’t default, deficits cause inflation

Yes, they could, if we continued stimulating the economy past full employment. If we stoke demand when we can supply no more–when everyone who wants a job has a job, when those working part-time but wanting full-time have found the latter, when discouraged workers have re-entered the workforce, when those who were underemployed have since found jobs more commensurate with their skill level, etc–then, yes, it can be inflationary. But a) we are a long way from that point right now and b) it’s only happened once in recent history: World War Two. We drove unemployment below 2% and kept on spending in deficit (in magnitudes we have never again even approached). As a consequence, we had to introduce wage and price controls (like rationing) and we encouraged people to buy war bonds rather than spend. So, yes, deficit spending can cause inflation, but only if the rest of the economy is going full speed and operating on all cylinders.

3. Deficits mean taxes

No they don’t otherwise they wouldn’t be called “deficits.”

4. Government spending is a waste

It certainly can be, just as private sector spending can be (particularly in bloated, monopolistic industries). We should constantly be on guard for this as there are plenty of jobs with social benefit that the private sector would not otherwise create. These are what the government should undertake. But regardless of how we decide, we must decide because the private sector simply does not create enough jobs to employ all those willing to work (and it’s just getting worse). That the government must do something is a given.

There is much more to say on this as it’s a difficult topic to cover quickly without leaving the reader with myriad questions (see "Further Reading" below for further explanation). The bottom line is this: there are a lot of things to dislike about the Trump tax plan. That it will add to the national debt is not one of them.

We already have many serious problems in the world, there's no point in making one up.

The situation is actually more dire than I have suggested above. I usually leave this out because it does not change the conclusion, it just takes longer to get there. But, for the interested reader I’ll add it.

The issue is this: non-Washington consists of two distinct groups, foreign non-Washington and domestic non-Washington. Now we have three entities that could be experiencing either a surplus or a deficit, but they must still add to zero. All three could be in balance, one in deficit and two in surplus, two in deficit and one in surplus, or one balanced, one in deficit, and one in surplus. Whatever the situation, they still add to zero.

Here’s the problem: the U.S. has a trade deficit, which means that domestic non-Washington has a deficit to foreign non-Washington (China and Japan being the biggest chunks of the latter–they, of course, have a surplus). We (as in domestic non-Washington) are therefore already starting in a hole even before we consider Washington’s position! In order for the U.S. private sector (domestic non-Washington) to have any net savings (i.e, a surplus), Washington’s deficit must be larger than foreign non-Washington’s surplus. To put some numbers on it, in 2016 the U.S. had a trade deficit of $502 billion: domestic non-Washington had a deficit of $502 billion with foreign non-Washington. The only way for domestic non-Washington to come out ahead is for their surplus with Washington to be larger than $502 billion–which, fortunately, it was at $585. And so domestic non-Washington–with a deficit of $502 to foreign non-Washington and a surplus of $585 to Washington–comes out with a net $83 billion surplus.

Take note! The implication here is that not only do we need the government to spend in deficit, but so long as we import more than we export then it must be at least large enough to offset the trade deficit. In 2016, a budget deficit of $400 trillion, for example, would have left the domestic non-Washington sector with net indebtedness (of $102 billion).